ARGENTINE ECONOMISTS PREDICT GLOBAL ECONOMIC

C O N F I D E N T I A L BUENOS AIRES 001377

SIPDIS

C O R R E C T E D C O P Y (TEXT)

E.O. 12958: DECL: 10/05/2018
TAGS: EFIN ECON ETRD PREL AR
SUBJECT: ARGENTINE ECONOMISTS PREDICT GLOBAL ECONOMIC
TURMOIL WILL IMPACT ARGENTINA VIA COMMODITY PRICES

Classified By: Ambassador E.A. Wayne for Reasons 1.4 (b,d)

Summary
--------------

1. (C) Three prominent Argentine economists told visiting WHA
DAS Chris McMullen October 2 that the global financial crisis
will have a bigger impact on Argentina's real economy than
its financial sector, due to the country's relative isolation
from international capital markets. They noted that falling
commodity prices and the sharp depreciation of the currency
of Brazil, Argentina's largest trading partner, will lead to
further deceleration of the local economy, raise fiscal
pressures, and possibly increase tensions within the Mercosur
trade bloc. Despite coming from different political
perspectives, they agreed there is little chance of the
opposition regaining control of the country anytime soon, and
predicted that the ruling party will win the 2011 elections:
"a Kirchner if the local situation has improved, otherwise
some other Peronist, but not the opposition." End Summary.

Discussion of Current Challenges, With Focus on Politics
-------------- --------------

2. (SBU) Visiting WHA Deputy Assistant Secretary Chris
McMullen and Ambassador Wayne met October 2 with three
prominent Argentine economists representing different
political views. Eduardo Curia, President of the Center of
Social and Economic Analysis, has been one of the most vocal
private sector supporters of ex-President Nestor Kirchner's
economic policies, although even he began raising concerns
about high inflation in early 2008. He commented that he
still supported the model of maintaining an undervalued
currency to support local industry, stating that he "is only
happy when the U.S. dollar is expensive." Daniel Marx, head
of AGM Consulting, served as Finance Secretary under
ex-President Fernando de la Rua, including during the 2001-02
economic crisis and default. Nevertheless, he is widely
admired as professional and non-partisan, and is frequently
consulted by senior GoA officials. The most junior of the
three was Gabriel Sanchez, President of IERAL, the think-tank
of Fundacion Mediterranea, which has been highly critical of
the Kirchner economic model and is linked to the
controversial economist Domingo Cavallo (Economy Minister
under both Presidents Menem and de la Rua). Nevertheless,
Sanchez is also widely admired as a talented and moderate
economist.


3. (C) The purpose of the meeting was to provide DAS McMullen
with an informal briefing on the state of the Argentine
economy. Therefore, the three focused on responding to the
Ambassador's request for comments on the impact of four
recent market-changing events: the financial crisis, rapidly
falling commodity prices, and the GoA's two recent
announcements that it would pay Paris Club creditors and was
considering a new debt exchange with holdout bondholders.
All three analysts also offered comments on the political
staying power of the Kirchners.

Real Economy in for Trouble; Financial Sector Cut Off
-------------- --------------

4. (C) Daniel Marx argued that ongoing international
financial turmoil will have a much larger impact on the real
economy than on the financial sector. Sanchez and Curia both
agreed, pointing out that Argentina is cut off from
international capital markets, but depends heavily on
commodity exports. They also noted that the Argentine
financial sector is small and isolated (and also relatively
liquid),so is unlikely to be too affected by external events
and also unlikely to transmit financial instability to the
non-financial sector.


5. (C) Marx argued that the two main reasons for recent
spikes in commodity prices have been high demand and easy
access to credit, which spurred speculation. Both of these
forces have diminished significantly, he pointed out, which
will reverberate through the Argentine economy. He noted
that Argentina was well placed to benefit from the run-up in
prices because it has been in the vanguard of technological
change in the agricultural sector. This allowed the country
to increase the production of soy, corn, and wheat by 70% in
the last 10 years, with only a 20% increase in land area
harvested. Now, with world demand slowing and with an
anticipated increase in competition from Brazil -- due to the
rapidly depreciating Real and slightly stronger Argentine
peso -- Marx predicted that Argentina will have a tougher
year in 2009 than it has seen since the 2001-02 crisis. Even
so, he expects the economy to hold up better than it has
during the other economic downturns of the last 10-20 years.


6. (C) Sanchez added that external problems would exacerbate
fiscal pressures for the Kirchner government. He said the
economy was already decelerating due to internal factors,
particularly high inflation, and that this would result in
lower tax revenues. He commented that the Kirchners have
always had two options: implement a credible anti-inflation
plan, bringing down growth to a sustainable level, or allow
it to happen on its own in an uncontrolled manner. By
rejecting the first option and instead continuing procyclical
fiscal and monetary policies in an attempt to keep the
post-2002 crisis boom going, the Kirchners now face the
prospect of having to cut spending, cut subsidies, and
increase prices for public services just as the economy is
decelerating rapidly. Given the GoA's greater dependence on
revenues from taxes on exports, Sanchez thought global
uncertainty and falling commodity prices would just
exacerbate these domestic trends.


7. (C) Marx agreed with Sanchez' analysis, adding that GoA
officials were sending mixed signals regarding economic
policies. In his opinion, there was a debate going on
between those who believe "the party can continue" and those
within the GoA that are extremely concerned about economic
problems in 2009. He thought one area in which this
disagreement would play out was over the exchange rate. The
President recently surprised private analysts by publicly
telling the heads of industry that the GoA could not
currently support the rapid depreciation of the peso -- using
a rather orthodox line of reasoning that a depreciated peso
would only lead to higher inflation. However, Marx worried
that, as export tax revenues fall, there will likely be
increasing support within the GoA to depreciate the peso in
order to make up the shortfall on higher export volumes.


8. (C) Both Marx and Sanchez thought that paying Paris Club
and re-opening the debt exchange to holdout bondholders could
help mitigate the impact of slowing growth and falling
commodity prices, as they have the potential to help
Argentina re-integrate into global capital markets. They
should also lead to lower interest rates on Argentine debt.
Marx argued that Argentina has been excessively punished in
the capital markets, with yields on Argentine 10-year bonds
currently in the 19-21% range. If the Paris Club and debt
swap initiatives are successful, he said, this should open
access to substantially cheaper credit, which would in turn
make longer term credit available, spur more private sector
borrowing, expand production, and enhance Argentine
industry's ability to compete against Brazilian and other
major trading partner manufacturers.

Possible Fallout in Mercosur
--------------

9. (C) All three economists predicted that another possible
result of world events was heightened tension among Mercosur
members. Sanchez commented that Brazil and Argentina had
chosen different paths in recent years, with Brazil pursuing
an expansionist outlook, negotiating international trade
agreements and being active in Doha talks. Meanwhile,
Argentina had become increasingly inward-focused, taxing
exports and trying to increase protection for local industry.
The result, he said, was that Brazil was gaining world
market share, while Argentina had diminished as a percentage
of total world trade. Therefore, he thought, the recently
depreciated Brazilian Real could cause bilateral conflict to
increase between the two.


10. (C) While not disagreeing, Marx commented that in the
1990s Argentina had a trade surplus with Brazil despite the
artificially strong peso. Now with a much weaker peso,
Argentina has a large trade deficit with Brazil. He
concluded that Argentina tends to import more from Brazil
when the peso is weaker, and that the result of a relatively
stronger peso (against the Real) may just result in a
substitution of Brazilian imports with those from other
countries.

Disagreement over GoA Protection of Industry
--------------

11. (C) The only area of mild disagreement among the three
surfaced following DAS McMullen's comment that it appeared
that Argentina might be over-taxing its most productive
sector, agriculture, in order to support less competitive
industry. McMullen asked whether this might reduce popular
support for the Kirchners. Curia argued that only 25-30% of
the population was associated with the agricultural sector or
areas of the economy benefiting from agriculture. Therefore,
he argued, supporting industry was more important, from a
political perspective. "If you do not have a sustainable
TURMOIL WILL IMPACT ARGENTINA VIA COMMODITY PRICES

industrial development plan," he said, "you will have high
unemployment and social tension." He added that unemployment
was terrible during the 1990s, when Argentina had pursued
"its own particular version of the Washington consensus," and
this led to the self-destruction of the Menem/Peronist
government and the presidential win in 1998 of opposition
politician Fernando de la Rua. This is why the Kirchners
still see urban industrial workers as their critical pillar
of political support, he concluded.


12. (C) Marx clarified that Argentina's industrial base is
evolving and is increasingly outside of cities and connected
to the agricultural sector. Sanchez added that only 20% of
the workforce is tied to industry, and that service sector
labor makes up the largest percentage of total employment.
He disagreed with Curia's assessment, arguing that sustaining
the Kirchners' metropolitan area, lower income political base
requires more work on reducing poverty levels rather than
increasing (already historically high) employment levels.
Therefore, he stated, the Kirchners' social spending programs
and price controls (especially for utilities) have been the
key elements in maintaining popular support.

Argentine Politics: Peronists Here to Stay
--------------

13. (C) Interestingly, all three independently offered views
on the political staying power of the Kirchners, coinciding
in the opinion that the opposition is fractured and will not
regain power anytime soon. Curia noted that the GoA is weak
under President Cristina Fernandez de Kirchner, compared to
the greater power her husband Nestor Kirchner wielded as
President. However, he pointed out that the opposition was
only able to find common cause during the March-July
agricultural strike because it went on so long and was so
damaging. That has not proven sufficient to solidify the
opposition going forward. The Kirchners know the opposition
will gain positions in Congress during the mid-term elections
in 2009, he said, but all three agreed that such gains will
not be sufficient to establish an opposition majority.
Sanchez added that the opposition only seems capable of
seizing power in Argentina when commodity prices are low, and
he thought that was not by accident: the only moments they
can muster the votes is when the economy is in shambles and
the Peronists are in disarray. Therefore, despite the
current administration's weakened status, all three were in
agreement that a Peronist is likely to win the next
presidential elections in 2011. Whether the next victor
proves to be one of the Kirchners or some other
as-yet-unidentified Peronist party leader, they said, will
depend on the state of the economy.
WAYNE